What’s the Cost of Investing in Mutual Funds?


real-cost-of-investing-in-mutual-funds

How much of your investment in mutual funds go to intermediates directly or indirectly?

I know that’s a tough question to answer, but it’s definitely worth knowing. The things that matter to you – right from effective returns to non-biased advice – are interwoven with this answer. Further, in the last 5-10 years, a big change in the commission and fees structure of mutual fund have rippled through the mutual fund industry. There have been regulations to limit mutual fund expenses and distributor’s commision, separation of advice from distribution, and charges for value-added services such as financial planning.

Regulators have taken these steps keeping in mind the interest of customers while supporting the mutual fund industry, which is still nascent and relatively small in India. However, these changes have certainly made the pricing and fees aspect of mutual fund industry a bit more complex.

fees and commision - everything about cost of investing in mutual funds
*Please note that we haven’t included other components of expense ratio such as marketing expense.

In this article, we will try explaining everything about explaining commission in the simplest possible way. In case you are have just started investing in mutual funds, check out this complete guide to investing in mutual funds for beginners in India.

Why bother about fees?

Whether it’s hidden distribution fee or the fee that advisors charge, they affect your pocket eventually. It goes without saying that a high commision or a fee model eats into your returns.

Generally, investors neglect the fees aspect as the differences between the best and the worst ones are just 1-2% per annum. However, one shouldn’t neglect the power of compounding. Even a difference of 1% in fee adds up to a good 30% in the long term.  

That’s why it’s a good idea to understand the different types of fees and commission.

Different types of Fees and Commission

We will talk about three kinds of charges  – distributor’s commissions, one-time charges, and value-added service charges.

  • Distributor’s Commissions:

This is a part of the expense ratio of the mutual funds.

What’s expense ratio? The expense ratio is the percentage of total assets that is spent to run mutual funds. For example,  if you invest Rs 1000 in a fund with an expense ratio of 1.5% per annum, then you are paying the fund houses INR 15 to manage your money. This involves the fund management fee, agent commissions, registrar fees, and selling and promoting expenses.

It should be noted that agent commissions are not part of the direct Mutual funds. That’s why the direct mutual fund is at least 10% cheaper than the regular mutual funds. For example, in general, for equity mutual funds, the expense ratio for direct funds is ~1% less than regular funds. Thus, for most equity scheme, cost of investing in direct mutual funds is 40% less than the cost for regular funds.

Please find the below the special annual limit of expense ratio for regular mutual funds:

Daily Net Asset Equity Funds Debt Funds
First INR 100 Cr 2.50% 2.25%
Next INR 300 Cr 2.25% 2.00%
Next INR 300 Cr 2.00% 1.75%
Over and above INR 700 Cr 1.75% 1.50%
  • The above-given rates are per annum and the expenses are calculated on a daily basis
  • 0.30% of total expense ratio could be charged on the fund if 30% of the fresh inflows are from cities beyond Top 15 cities in India

The commission that distributors get from fund houses is part of this expense ratio. However, ‘investment advisor’ or ‘registered investment advisor’ don’t get any commision from fund houses, as they generally recommend direct mutual funds.

  • One-time Charges

There are some charges that are applied only one time to investors – when they join or leave a scheme. These charges include entry load (not applicable now), exit load, and transactional charges.

  • Entry Loads (0%) – Entry loads are the charges that are levied when the units are purchased. Currently, mutual funds are not allowed to charge entry load.
  • Exit Loads (0.1-3%) – Exit load is a fee charged to an investor for exiting or leaving a scheme. The aim of collecting this fee is to discourage investors from exiting.  Generally, the fund charges fees between 0.1% and 3% depending on the holding period. No exit load is charged beyond the holding period.
  • Transaction Charges: These are one time charges levied on the investment worth more than INR 10,000 and paid to distributor or intermediary who is selling the fund.
New Investor to Mutual Fund INR 150
Existing Mutual Fund Investor INR 100
SIP Investment INR 100

 

  • Value-added Services:

As per SEBI regulation, registered advisors can’t earn any commission from fund houses. That’s why advisors generally offer direct fund, which is cheaper than regular funds.

These advisors charge for value-added services such as financial planning, fund recommendation, and portfolio advisory. In general, these pricing model are based on either portfolio performance or asset under management.

Typically, advisors charge 0.25-1% of assets under management as a fee.

Common Points of Confusion for Beginner Investor

  • Investing through mutual fund distributor is always a cost-effective option 

Fund houses pay a certain amount of commission to distributors. Typically, they pay an upfront commission when you invest in funds. Subsequently, they pay a trail fee. In many cases, distributors aren’t transparent about theses commision and even try to push high commission products.

In these cases, regular funds aren’t cost-effective options. First, investors are paying high commission to distributors indirectly. Hence, the effective returns are lower. Second, in some cases, distributors can push even low-performing funds just because they offer high commission.

  • Investing in direct mutual funds is always a better option

That’s not always true. For unqualified investors, incidental advice and reviews hold a great deal of value. Devoid of hand-holding of distributors in the direct plan, investors might opt for funds that are suitable for risk profile or that’s performing badly.

That’s all you need to know about commisions and fees. If I have missed out on anything or you have any feedback or query, please post in comments. I will personally reply to each of your comments 🙂

Now that you have an understanding of fees and commission in mutual funds, you are ready to get started. Here is a complete guide to investing in mutual funds.

Written by

Ajitesh Abhishek